TMI Blog2021 (10) TMI 907X X X X Extracts X X X X X X X X Extracts X X X X ..... deduction would be entertained and decided by the Tribunal. - We find substance in the submissions made by the ld. AR of the assessee and accordingly, we direct the AO to delete the addition made on this count. Thus, the grounds raised by the assessee on this issue are allowed Disallowance of expenditure u/s 37(1) - administrative expenses and payment of salaries - assessee submitted that the expenditure was incurred for the purpose of business, and it is allowable as business expenditure if it is incurred on the ground of commercial expediency - HELD THAT:- It is only after the business is set up that the expenses incurred in the business can be claimed as permissible deduction under Section 37 of IT Act. For commencement of a business, there must be some income generating asset or income earning structure. In the case on hand, the assessee is incurring capital expenditure and till date of FY ending, the assessee has not commenced its commercial operations. As per the balance sheet filed by the assessee, the assessee is incurring capital expenditure, therefore, factory maintenance and repair maintenance expenditure do not arise. The assessee failed to establish that exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of capital expenditure - ₹ 42,52,628/- 4. When the assessee preferred an appeal before the CIT(A), the CIT(A) confirmed the order of AO. 5. Aggrieved by the order of CIT(A), the assessee is in appeal before the ITAT. 6. As regards the issue of addition of ₹ 22,50,00,000/- towards business income u/s.28(i) of the IT Act, the AO observed that from Financial statements for the year ending 31.03.2017, the assessee company had shown an amount of ₹ 22,50,OO,OOO/ as 'Long term Deposit from Associates' (Ref. No.22 of Note to Accounts) which was classified under Unsecured Loans. 6.1 In the said Note 22 of the financial statements it is stated as under: The Company M/s Sanvita Bio Technologies Private Limited has entered Marketing Agreement for sale of its products with Boehringerlngelheim India Private Limited, in order to market and sell all of the animal health products thot it is manufacturing (or) will manufacture in the future with global partner (Boenringerlnselheim India private Limited) with conditions as mentioned in the agreement. For the assignment of global exclusive distribution rights for its pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... related expenditure. Further it was stated that this corresponds to period of 15 years and further renewal period of 5 years, in this process, the assessee will incur huge losses for a long period. To compensate these losses, it has received an amount of ₹ 22.50 Cr. from the 'distributor'. 6.6 Rejecting the above contention of the assessee, the AO observed that the assessee Company had received this money in the process of business transaction and it was surprising explanation from the assessee that in future it will incur losses and to compensate the future losses it had received this money. The AO opined that this was a colorable devise used by the assessee to evade the tax on this receipt, as no prudent business concern will compensate the future losses of another business concern i.e. assessee company. Further, he observed that the receipt is pertaining to the rights of distribution and ought to have been admitted as business receipt. The claim of the assessee that the receipt of ₹ 22,50,00,000/- as 'unsecured loan' by the assessee company cannot be accepted. 6.7. In view of the above observations, the AO treated the amount of ₹ 22,50,00 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness right of appointing distributor in the territories across the globe and appointed Mis. BllPl who in turn has paid the consideration for purchasing the distributor rights. This amount received is not linked to the pricing of the product or to compensate future losses. There are separate clauses in the agreement as to how the cost of the product is reimbursed by the distributor and the profit margin is shared between them. There are no trademarks foregone by the appellant as no trademarks were listed in the agreement. It is seen from the appellant's website that the appellant company has developed vaccine for Foot Mouth disease in animals and the distributor being a globally reputed pharmaceutical company in Animal Health care products intended to lock in the marketing rights of these products by purchasing them for a hefty non-refundable consideration which it did so. There is no dispute that the compensation has arisen on account of exploitation of business rights and the same is taxable as business income u/s. 28(i) of the LT. Act. On seeing an opportunity in appellant's products, the Distributor has secured the exclusive global distribution rights even though, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions as laid down in the said agreement by the appellant. 9.1 He submitted that for fulfilling the clauses in the agreement as well as also the other clauses in the said agreement, of the distributor viz., M/s BOEHRINGER ingelheim India Pvt. ltd, Mumbai, the Manufacturing company, viz., the appellant has to lose substantial amounts for 15 Years from the date of agreement made on 01-04-2016, or from date of starting its manufacturing of the said products and to compensate the same, the distributor has paid the amount of ₹ 22.50 Crores as non refundable advance, which thus, it cannot be considered as income for this assessment year 2017-18 in the hands of the appellant. 9.2 He submitted that the assessee company has to bear the losses as noted below in view of the said agreement, which thus, the distributor has paid the above advance of ₹ 22,50,00,000 to the assessee: (I) That the sole consideration payable by distributor to manufacturer for granting distribution rights to the products manufactured! will manufacture; [ii) loss towards trade mark(s) and trade dress; (iii) loss towards use of trade mark(s) and trade dress by the distributor even after t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is under an obligation to render services in the future has not been disputed by the AO considering the fact that the amount of advance is received towards future services for which costs are to be incurred in future and the same is non-refundable, no addition need to made during this year. Moreover, the receipt in advance amount do not come within the provisions of sec 4 5 and they cannot be treated as income in the hands of the appellant. 9.4 He submitted that the financial statements of the company are prepared in accordance with the Indian General Accepted Accounting Principles (GAAP) under the Historical Cost Convention on the accrual basis except for certain financial instruments which are measured at Fair Values. GAAP comprises mandatory accounting standards as prescribed u/s 133 of the Companies Act, 2013 read with relevant rules issued there under. The accounting policies adopted in the preparation of the Financial Statements are consistent with those followed in the previous year. 9.5 In view of the above submissions, the ld. AR finally submitted that the addition made of ₹ 22,50,00.000/- is not justified, is bad-in-law and is against to the Principles of Na ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the year under consideration. The relevant part of the agreement in this regard is as under: Article 4 Consideration/Prices: 4.1 For the assignment of global exclusive distribution rights to Distributor and/or a distributor affiliate to any and all products which manufacturer produces/will produce and holds/will a marketing authorization, distributor shall pay to manufacturer ₹ 22,50,00,000/- (in words Rupees Twenty two crores fifty thousand only) 4.2 The parties agree that the transfer price shall be 50% of distributor s net selling price of a product as defined in Annex A until 31 Dec 2023. From 1 Jan 2024 to 31 Dec 2027 the transfer price shall be 30% of distributor s net selling price as defined in Annex A. From 1st Jan 2028 the transfer will be 40% of distributor s net selling price as defined in Annex A. Manufacturer grants distributor the right at any time until the end of the initial contract term (15 years) to acquire up to 25% of the shares (equity) of the manufacturer at a price agreed upon by way of fair valuation. 4.2.1 The parties have the common understanding that the transfer price is targeted to be at or above. Full costs of goods ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d dominion over the said funds, then, it is difficult to characterize them as the income of the assessee. [Para 21] On an analysis of the relevant bye-laws regarding sugarcane price and non-refundable deposits, the following salient features were discernible: 1. The price of sugarcane was fixed every year by the Board of Directors, on a consideration of relevant factors. 2. However, so long as the share capital contributions of the State Government and/or the loans taken on capital account from IFCI and other Central Financial Institutions remained outstanding, the price as fixed by the State Government was liable to be paid by the society. 3. Every year the society shall collect from the members supplying sugarcane a non-refundable deposit at the minimum rate of Re. 1 per ton. In fixing the rate, the into account the liabilities towards the loan due to IFCI and other loans borrowed for capital expenditure and the repayment of time deposits received from the members. 4.. The Society was to continue to collect the deposits so long as it held Government share capital and other loans (on capital account) were outstanding. However, the deposits collected by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contingency had been contemplated under which the members could demand the repayment of the deposit. Nor could it be said that even after the happening of the event specified in the bye-laws, the right to demand repayment becomes illusory in view of the discretion reserved to the Board of Directors of the Society. [Para 28] Once the loans of the description mentioned in the bye-laws which were outstanding on the date the deposit was made were repaid, the Board of Directors of Society was bound to convert the deposit amount into shares. The discretion was always coupled with a duty; the discretion could not be used to circumvent the obligation cast under the law or contract governing the parties. On the occurrence of the specified event, namely, the repayment of the loans referred /0 in the bye-law and the Government share capital, the member/depositor could clutch at a legally enforceable right to demand repayment, might be, in the form of conversion into additional shares. [Para 28] Thus, the retention of the deposited money with the Society in order to utilize the same for repayment of term loans, etc., did not denude the amount of its character of 'deposit' ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tive circumstance to indicate that deposits belonged to the members. [Para 33] Further, the manner of user of the deposit was limited by the bye-laws. Which provided that the amount of deposits shall be utilized jar the repayment of term loans taken for the capital expenditure from the banks and financial institutions. The fact that depositor could seek transfer of the deposit to another member by filing an application for that purpose again highlights the fact that the power of disposal of the deposit lies with the member. The obligation to convert the deposits into shares subsequent to the repayment of certain types of loans coupled with the right given to the member to seek transfer of the amount lying to his credit and the obligation to refund the deposit to the depositor on cessation of his membership or to his legal heirs in case of death subject of course to certain restrictions, were all pointers that the assessee could exercise dominion over the deposits only in a limited sphere. On a consideration of the bye-laws as a whole, it was difficult to hold that either the assessee or the depositor would exercise complete dominion over the deposited amounts. If so, it w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le and refundable deposits could not be treated as the income of the assessee-society. Therefore, appeals filed by the assessees were allowed. [Para 41J OTHER FUNDS As regards the Chief Minister's Relief Fund, Late YB. Chavan Memorial Fund and Hutment Fund, the assessee had merely acted as an agent in collecting the amounts and remitting the same to the Government/Trustees. In truth and in substance, the money collected by the assessee was not reaching the assessee as part of its income, but the collection was made for and on behalf of the person to whom it is payable'. It had no manner of right or title over the said monies. The amount collected towards Hutment Fund stands on no different footing. It was meant to be handed over to Collector for the purpose of providing shelter to landless poor inhabitants within the area of operation of the sugar factory. Therefore, the conclusion reached by the Tribunal and the High Court that those receipts should not be treated as income of the assessee was justified. [Para 44 J As far as Sugar Cane Development Fund was concerned, the Circular dated 18-8-1986 in which certain directive principles had been laid down to reg ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s appeals were allowed and the Commissioner's appeals were partly allowed to the extent indicated above. 11.4 Considering the totality of the facts and circumstances of the case, we find substance in the submissions made by the ld. AR of the assessee and accordingly, we direct the AO to delete the addition made on this count. Thus, the grounds raised by the assessee on this issue are allowed. 12. As regards ground No. 14 relating to the addition of ₹ 42,52,628/-, the AO observed that from the Profit and loss account, total amount of ₹ 42,51,628/- was claimed as expenditure for the year under consideration. He further observed that, from the financials, the assessee company had not carried out any business during the financial year under consideration. He also found that the Company had not provided any depreciation during the year, as the project is still in work in progress stage. He, therefore, issued a show cause notice proposing disallowance of the expenditure so claimed as under: In your submissions, you hove stated that depreciation is not provided since the project is still in work in Progress stage and operations are not yet started. Further, yo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act refers to the date of setting up of business and the previous year would commence only thereafter. The assessee has not produced any evidence to prove that it has actually set up its business. The Hon1ble Supreme Court in CWT Vs. Rama Raju surgical Cotton Mills ltd. [1967] 63 ITR 478 (SC) ruled that a unit cannot be said to have been set up unless it is ready to discharge the functions for which it is being set-up. The installation of machineries, purchase of land, etc. were merely operations for setting up of business and business would be set-up on culmination of these operations. Similar view was taken by the Madras High Court in CIT vs. Electron India (241 ITR 1661 [20011 and Delhi High Court in CIT vs, Samsung India Electronics ltd. [2013] [356 ITR 354] [Delhi]. Therefore, the AO is right in holding that these expenses are to be capitalized till the setting up of the business and commencement of operations. In view of the same, Ground Nos. 10 to 14 raised by the appellant on this issue are DISMISSED. 15. Before us, the ld. AR of the assessee submitted that the expenditure was incurred for the purpose of business, and it is allowable as business expenditure if it is i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n incurred. The Section 3 of the Income Tax Act, which defines previous year , in the context of first year of business operation, states that the same previous year shall start from date of setting up of business. Accordingly, date of setting up assumes importance because expenses prior to setting up of business will not be covered under section 37 of IT Act. This is however subject to section 35D of IT Act wherein specifically provision has been made by legislature for allowance of preliminary expenses. It has to be borne in mind that there is a distinction between setting up of a business and commencement of a business. The Bombay High Court in Western India Vegetables Products Ltd. v. CIT [1954] 26 ITR 151 has examined the concept and noticed the difference between commencement and setting up of a business by observing:- The important question that has got to be considered is from which date are the expenses of this business to be considered permissible deductions and for that purpose the relevant section defines the previous year as ?and for the purpose of a business the previous year begins from the date of setting up of the business . Therefore, it is only after the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to customer for reward, some kind of goods or services. In other words, when the trader start providing such goods and services, the business is said to have commenced but the same may not hold good for set up of a business, which is a stage before the commencement. To set up a business, the following activities become relevant:- 'Preparation of a business plan; establishment of a business premises; research into the likely markets or profitability of the business; acquiring assets for use in the business; registration as an entity and under the local laws etc.' The said list of activities are not exhaustive and facts of each case need to be considered. Indeed purchase of goods would amount to commencement of business, but before the said act, spade work and efforts to commence have to be undertaken. A trader before actual purchase would possibly interact and negotiate with manufacturers, landlords, conduct due diligence to identify prospective customers, spread awareness etc. These are all integral part and parcel of the business of a trader. The said activities continue even post first sale/purchase. When first steps are taken by a trader, the business is set up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 377; 11,55,395 9. Bank charges (as per Note No. 16) - ₹ 47,734 Total ₹ 42,52,628 17.6 From the above details of expenditure, it is clear that at Sl.No. 3, 4 5 are in the nature of capital expenditure. As per the balance sheet filed by the assessee, the assessee is incurring capital expenditure, therefore, factory maintenance and repair maintenance expenditure do not arise. The assessee failed to establish that expenditures incurred under Sl. No. 3, 4 5 are not directly relating to the installation of the project. The assessee has incurred R D expenditure earlier, which has been capitalized and, therefore, this expenditure cannot be treated as revenue expenditure since the assessee has not yet started commercial production. In view of the above observations and considering the totality of the facts of the case, this ground of the assessee is partly allowed. Thus, the assessee gets a relief of ₹ 25,20,991/-. 18. In the result, appeal of the assessee is partly allowed in above terms. Pronounced in the open court on 5th October, 2021 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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